Emerging Markets View: What Our Analysts Are Reading

EM View

Emerging markets are caught between the rebound in risk appetite and an appreciating dollar, according to Business Insider. Sam Osborn, Practice Leader for FSG’s Global Analytics, agrees with the article’s sentiment.

“The catalysts of global currency volatility are primed to act. Any changes in the forward guidance from the ECB or US Federal Reserve has the potential to rattle investors and drive sharp currency swings in emerging markets.  FSG clients should read our FX Quarterly report for additional information on the operational strategies executives can employ to mitigate the effects of exchange rate fluctuation.”

In a more positive light, India’s economy likely grew at its fastest in two years according to a Reuters poll. Though this good news, it’s not an immediate result from India’s recent landmark general election.

“Economists are expecting the latest figures from India to show that the country grew at 5.3% during its April-June quarter. If achieved, this would be India’s fastest growth since Q1 2012, indicating positive investor and consumer sentiment,” says Shishir Sinha, Senior Analyst for Asia-Pacific at FSG. “Executives should keep in mind that the Modi government would have little direct impact on these figures since they officially took up the helm in June.”

Meanwhile, Argentina continues to be met with skepticism as companies fear a radical turn in Argentina, according to the Financial Times.

“While Argentina took steps to change its policy course earlier this year by devaluing the peso, cutting subsidies, and making efforts at rapprochement with the Paris Club, those efforts were stymied by the default,” according to Gabriela Mallory, senior analyst for Latin America. “Argentina has once again switched gears to even more interventionist and expansionary economic policies that make FSG’s downside scenario of a deepening recession more probable.”

FSG clients can stay up to date with analyst commentary on the latest emerging markets headlines on the client portalNot a client? Contact us to learn more.


Emerging Market View: What Our Analysts Are Reading

EM View

India’s newly elected Bharatiya Janata Party (BJP) government announced its first budget last week, and according to the Wall Street Journal, it proved a letdown for those expecting big-bang reform, MNCs included.

“While it is a well-balanced fiscal plan with focus on reviving consumption and investments, markets have not been overly pleased and experts find certain growth targets to be quite unrealistic. The absence of specifics on several big-ticket items and lack of an overarching vision should rightfully disappoint companies,” says Shishir Sinha, FSG’s Senior Analyst for Asia Pacific.

(Readers can view FSG’s original expectations for India’s BJP government here.)

Last week, Portugal’s Banco Espirito Santo SA bonds hit record lows after parent company Espirito Santo International reportedly missed a debt payment, rekindling market fears and reminding investors that the eurozone’s woes are far from over.

“Executives should be wary of headlines for recovery in WEUR, and prepared for the heavy downside that could accompany bank failure. Banco Espirito Santo, a Portuguese bank, delayed payments on some securities, reminding us that just because banks have not been in the news does not imply that they are healthy. FSG’s WEUR Regional Outlook outlines how banks could impact MNCs throughout the region,” says Lauren Goodwin, Senior analyst for Western Europe.

In Latin America, Argentine presidential hopefuls are dealing with the issue of debt negotiations and exploring opportunities for business-friendly reform, according to Reuters.

“As Argentina strives to negotiate with holdouts to avoid default, executives should consider the potential for improvement as elections approach in 2015. The current frontrunners favor negotiating with holdouts and would likely be more pragmatic and business-friendly than President Fernandez,” says Christine Herlihy, FSG’s Senior Analyst for Latin America.

In global news, Forbes recently released an article on local companies competing with foreign investors in emerging markets, citing a new study by Boston Consulting Group and echoing past FSG reports.

“Echoing the same message in FSG’s report Winning the Race For The Market Diamond, local competition gaining market share in emerging markets is an increasing concern for multinationals, particularly for MNCs that focus on the burgeoning emerging market middle class. Read the report to understand the strategies other companies have used to battle the evolution of growing domestic companies,” says Sam Osborn, Associate Practice Leader for FSG’s global analytics.

Back to the Future for Emerging Markets?

“Back to the future”

Despite recent volatility, emerging markets remain in traditional positions within the global economy.  As in the past many emerging markets can be characterized as low-cost production and export hubs, with favorable exchange rates, cheap company valuations, and attractive demographics that can support domestic consumption growth.  While these emerging markets drivers are largely familiar in aggregate, not all emerging markets are created equal.

H2 2014 GPD Blog Post Image #1

The recent period of emerging markets volatility changed corporate perceptions of emerging markets.  Emerging markets went from star “outperformers” to high-risk markets, with companies refocusing resources on recovering developed markets.

H2 2014 GPD Blog Post Image #2

However, the revival of developed market growth will benefit emerging markets as many retain the traditional producer-consumer relationship with develop markets.  That said, the rising tide may not lift all ships. Emerging markets where costs of doing business have increased find that companies are reallocating investment toward lower-cost production centers and/or markets with a more vibrant domestic consumer base.  For example, Samsung recently announced plans to invest $4.5 billion into building two production plants in lower-cost Vietnam in an effort to preserve margins. FSG clients can read more about our emerging markets framework and country-specific management actions by downloading the latest Global Performance Drivers report.

Six Pricing Strategies to Offset Emerging Market Volatility

Companies operating in emerging markets are struggling to meet top-and-bottom-line forecasts, in no small part due to heightened exchange rate and inflation volatility.  With competition from low-cost local companies from other multinationals at the higher end, margins have been squeezed by pricing pressure.  Not only has increased competition made pricing a particularly difficult challenge to manage, but local consumers also often have different price sensitivities within countries, compounding the difficulty across a diverse portfolio of countries.

Pricing Strategies Blog Post Image

FSG profiled six pricing strategies that companies have taken to protect performance in a volatile environment:

  1. Escalating contracts – One FSG client in the chemicals industry signs contracts with many of its customers that have built-in price increases based on key variables such as exchange rates and inflation to account for potential market volatility effects on margins. In situations where exchange rate-controls are built into contract, they shift sales from local production to dollar-based exports
  2. Leverage objective indices to negotiate prices – Companies that sell to governments or businesses, can pre-negotiate price increases based on trusted, third-party indices. This strategy is, particularly effective in markets like Venezuela and Argentina, where government statistics alone are not be fully trusted. This strategy allows for greater confidence in discussions about price increases
  3. Reach more consumers with a credit program that eases the burden of large purchases – Many emerging market consumers do not have the ability or willingness to make large outlays, so extending credit or creating purchasing plans can help customers purchase products. Customers do not receive a discount, just the perception of a discount with the purchase price broken up in multiple payments, sometimes with additional margin built in to offset the float
  4. Pricing scorecard with built-in disruptors – One FSG agricultural client uses pricing scorecards that take into account changes in variables such as raw materials, exchange rates, and inflation when making pricing decisions. They are developing scenarios involving certain disruptors, including macro and industry-specific factors, that may affect the current cost structures of their products over the medium term
  5. Implement price sensitivity research on a highly localized level – Understanding local market nuances is key in enabling prices to be changed effectively, and by elevating the importance of local consumer insights one FSG consumer goods client was able to better incorporate pricing recommendations into their strategies.
  6. Perfect operational hedging – By aligning their costs and revenues in local currencies, one FSG client minimizes the effects of currency fluctuations on their pricing decisions by developing over time a near-perfectly-hedged operational footprint across their regions.

Pricing will always remain an evergreen issue, and as our clients consider the various costs and benefits of pricing strategies FSG will remain with them every step of the way.




How to Avoid Currency Losses in Emerging Markets

In 2013, many executive missed performance targets despite meeting volume and market share goals. The culprit was exchange-rate volatility, which caused many companies to miss revenue and profit targets after local currencies were translated to dollar or euros. According to FiReAPPS, US-based multinationals lost an estimated $17.8 Billion dollars in 2013 due to exchange-rate fluctuations in emerging markets.  For an emerging market executive, a 10% gain in profit and sales in a given market was wiped out by a 10% decrease in the value of the local currency.  The list of emerging market currencies that depreciated by more than 10% against the US dollar is extensive, including: The Russian ruble, Indonesian rupiah, Brazilian real, South African rand, and Turkish lira.  Currency depreciation turned local-market success stories into earnings disappointments.

FX Quarterly Q1 2014 Blog Post Image 1

*Source: Frontier Strategy Group analysis, Bloomberg

With the risk-return payoff for shifting towards developed markets, executives should consider high levels of emerging market currency volatility to be a given in 2014.  Exchange-rate volatility can wreak havoc on internal operations and business partners, but its effects can be mitigated. A cross-functional approach to contingency planning ensures that all key elements of a business including, sales, supply chain, talent and finance are ready for the next bout of turbulence.  The question for emerging market leaders should be how to manage volatility, not how to avoid it.  This problem should be solved at the local and regional level, no longer just at the corporate treasury. Emerging market executives have a number of operational strategies in their arsenal for minimizing the impact of FX fluctuations.

Before choosing or recommending a course of action, it is vital to determine an organization’s objective in managing currency volatility. Many companies focus simply on maintaining margin in an environment characterized by currency volatility. More opportunistic companies will use the environment to build market share.   The strategies detailed in our FX Quarterly series can be implemented with little to no support from the corporate treasury.

FX Quarterly Q1 2014 Blog Post Image 2

*Source: Frontier Strategy Group analysis

Emerging-Market Meltdown? It’s Time for Action, Not Distraction

The financial media has been dominated by cries of “Emerging-Markets Crisis” in the past week, as both currencies and stock markets tumbled. Corporate executives would be well served to turn off the television and instead take a second look at their 2014 business plans.  Multinational companies have their work cut out for them to ensure a successful year ahead, so it is essential that their emerging-market executives separate signal from noise and focus on their most important management challenges.

With the media focused on hour-by-hour events, I hope to provide FSG clients with a big-picture view that puts recent news in perspective and integrates the comprehensive resources you have available today. First, let’s clarify what’s really been happening in the markets, and what is truly relevant to corporate leaders.

1.    Corporate investment in emerging markets remains strong, despite capital-market volatility.

Companies with global ambitions are doubling down on developing markets, not retreating. More than 60% of corporate foreign direct investment went to emerging markets in 2013, despite portfolio “hot money” moving in the opposite direction. FSG’s MNC sentiment tracking shows that interest in frontier markets has doubled in the past year, indicating likely direct-investment increases in even riskier (and still fast-growing) markets.

The crisis today is one of confidence among money managers, as “tapering” of the US Federal Reserve’s quantitative easing program increases their cost of capital. A lower risk appetite has naturally reversed the flow of capital into emerging markets that surged in 2009. The economic fundamentals of most emerging markets have not changed notably, other than the effects of the currency volatility itself.

We have seen this movie before, in May 2013’s “taper tantrum” and its August sequel, when uncertainty over the timing of Fed tapering triggered abrupt emerging-market currency selloffs. The Brazilian real, for instance, lost and then regained over 12% of its value over the span of six weeks in August and September – and lost it again starting in November. Everyone knows the Fed will reduce stimulus further over time, which means further pullbacks from higher-risk markets are inevitable. So, the surprise last week was just about timing, not substance.

2.    The media uses “emerging-markets crisis” as shorthand, but last week’s market turmoil was really about relatively few countries – and the news was not as startling as portrayed.

Yes, there are real reasons for MNCs to be concerned about political instability in Turkey and Ukraine, and economic policies in Argentina and China – all of which have dominated headlines recently. But at least for FSG clients, these risks should have already been built into 2014 plans.

Our September report on 2014 Global Performance Drivers highlighted Ukraine, Turkey, and Argentina as most vulnerable to a liquidity crisis because of their high levels of short-term external debt. For such countries, even moderate changes in investor sentiment cause major currency movements. Unfortunately, the media tends to gloss over key differences in their market fundamentals that matter to companies.

3.    Don’t let fear of “contagion” cloud your analysis of emerging-market opportunities.

“Contagion” implies that markets with real problems are tightly connected, so that a liquidity crisis or spending crunch in one will swiftly spread to many others. The markets that were most troubled last week generally do not have tightly linked financial markets. Trade links generally connect emerging economies more tightly with developed markets than with each other (with China a notable exception). We believe that corporate planners should be more concerned about downward pressure on emerging-markets growth resulting from linkages with the stagnant Eurozone than from linkages with a volatile Argentina or Ukraine.

4.    Managing currency volatility should be a top priority for MNC leaders in 2014.

The most serious risk is not of contagion collapsing currencies across emerging markets, but rather repeat bouts of currency volatility driven by fund-manager portfolio reallocation and herd mentality. This can have deeply disruptive effects. Our Events to Watch in 2014 report lists currency volatility as the most likely cause of 2014 plans going awry. As a result, we have initiated regular coverage of currency movements and trends for FSG clients in our new FX Quarterly series, which we will update at the end of February.

Some markets are likely to experience extreme volatility on an ongoing basis (Argentina, Iran, Syria, and Belarus top our volatility index forecast). FSG analysts are closely watching indicators such as short-term external debt, current-account balances, and portfolio capital outflows to monitor when markets are in the greatest danger of a currency crunch, and we encourage you to do the same using FSG’s Monthly Tracking Tool.

5.    Take action now to mitigate the impact of currency volatility on your 2014 performance.

Currency volatility can wreak havoc on internal operations and among business partners, but its effects can be mitigated. A multi-functional approach to contingency planning ensures that all key domains – from sales to supply chain, from talent to finance – are ready for the next bout of turbulence.  The question for emerging-market leaders is how to manage volatility, not how to avoid it.

  • Formulate contingency plans for profit repatriation

Currency depreciation can turn what seems like a local-market success story into an earnings disappointment from the corporate perspective. The worst-hit markets may compound the problem by instituting capital controls to prevent further flight and devaluation. Given the recent “pivot to profitability” in how emerging-market executives’ targets are set (as opposed to traditional revenue targets), regional general managers’ careers may suffer in the absence of a structured profit repatriation strategy.

  • Support local partners

Most MNCs depend on local distributors, suppliers, and other partners who lack the scale or sophistication to manage an extended period of currency volatility. Proactively providing liquidity, attractive repayment terms, and temporary discounts could earn enduring loyalty – and even turn an arms-length relationship into an affordable acquisition opportunity.

  • Evaluate product localization

Consider adopting a localization strategy to mitigate the impact of these possible scenarios by producing and sourcing locally. Factoring in currency impacts to market-share gains and government incentives may change previous cost-benefit assessments of going local.

  • Review your geographic portfolio

Identify the fundamentally healthy markets where companies are likely to pull back but your company is underpenetrated – many markets with strong domestic demand as their key economic driver should be less affected once the dust settles. Smart companies are adjusting their geographic footprint by assessing regional opportunity at the level of provinces (e.g., ASEAN and Latin America) and country opportunity at the level of cities (e.g., Russia and India).

  • Consider investing more aggressively in frontier markets

While many emerging-market forecasts have been revised downward, frontier markets have exhibited much stronger performance, in terms of both growth expectations and equity-index performance.  Markets such as Nigeria, Peru, and Kazakhstan will be resilient regardless of currency shocks, thanks to their modest short-term debt and healthy levels of private consumption.

6.   Executives in emerging markets must aggressively manage perception and expectations at the corporate center.

The very experience that makes seasoned emerging-market leaders unfazed in a period of volatility can make them forget how their colleagues at headquarters feel when the names of far-off markets are suddenly crawling across their TV screens day after day. When investors get nervous, the Board, CEO and CFO have to justify their investments in emerging markets that they may not even think about on a regular basis. When that happens, it’s essential that expectations and assumptions are well aligned between the corporate center and leaders in the regions.

  • Reassess 2014 targets and resource allocation

Companies should adjust forecasts down in the markets experiencing the most acute currency devaluation. Central banks may raise interest rates to support the currency and maintain prices on imported goods. The trade-off for higher rates will be slower-than-expected economic growth. As economic conditions change on the ground, any changes to corporate targets and plans should be swift and data-driven.

  • Get corporate buy-in to triggers for mid-year course correction

It’s time to be proactive in resetting expectations and, if necessary, re-making the business case for emerging-market investment. Regional GMs and country managers should demonstrate that they have specified key risks to the plan (FSG’s short list of Events to Watch in 2014 spans all regions of the globe), and have documented contingency plans. Agree in advance on events that would trigger a reset of goals or course correction in strategy. Companies that systematically monitor and adjust to changes in emerging markets grow market share twice as fast.

Don’t let Wall Street distract you from execution – or rewrite your business plans.

As an executive responsible for international growth, in a time like this it’s essential to not be distracted by the media’s emerging markets storyline. Keep your eye on what matters to your company’s success, and the timeframe in which you are committed to deliver results. You don’t control the markets, but you can control your business.

Do You Know Which Emerging Market Is At Risk Of A Liquidity Crisis?

Ukraine Liquidity Crisis
The economy of Ukraine is in serious trouble. To provide some context, Standard & Poor’s recently downgraded the quality of Ukraine’s debt to the same level as Greece.  With a current account deficit of about 8 percent of GDP, Ukraine’s rapidly diminishing foreign currency reserves stand around only 2.5 months of import cover.  In the next couple of months, Ukraine’s debt repayments could exceed their cash reserves, leading to a balance-of-payments crisis and possible default.  With recent economic data all pointing toward an increasingly deteriorating macro-environment, executives operating in Ukraine need to be prepared for the worst.  Even though the country has been able to teeter on the brink of default for an extended period of time so far, the risk and consequences for multinationals are so significant, that companies need to have a plan in place in case this risk materializes.

There is plenty of literature on the reasons for Ukraine’s issues, but not much information on the potential business impacts.  So what would a liquidity crisis mean?  For multinationals, there would be three main effects:

  1. First, expect a large devaluation (perhaps as large as 30%) of the Hryvnia.
  2. Second, both B2B and B2C multinationals’ ability to get paid will suffer as systemic credit dries up.
  3. Third, governmental policies would shift toward populist measures in order to appease the electorate in advance of 2015 presidential elections.  These measures could include increased import tariffs and subsidies for domestic producers, giving advantage to companies that are able to produce locally.

To better gauge the specific implications of Ukraine’s liquidity crisis, FSG has identified the industry-specific consequences below.



Consumer Goods/Retail Supported by wage increases, consumer demand has been the strongest driver of the economy.  FSG expects consumer spending to slow dramatically as consumer demand is rapidly depressed by the Hryvnia’s devaluation and combined with slowing wage growth.  This would also impact the government’s ability to pay salaries, pensions, and other social benefits, further harming consumer expenditure.  In previous instances of liquidity crises, consumers have shifted their spending patterns to more traditional channels such as mom and pop stores in response.
Healthcare Accounts receivables will come under pressure as both public and private entities struggle to meet payment obligations.  With the public sector supplying 55% of the total health expenditure in 2013, multinationals should anticipate both decreases and delays in reimbursement.
Heavy Industry Expect delays and/or cancellations of infrastructure developments and capital-intensive projects as government funds are shifted toward urgent repayment capacity.  B2B demand will also weaken as local companies face credit availability issues and lower purchasing power from a devalued Hryvnia.
Technology In an effort to protect domestic industry, companies importing hardware goods into Ukraine can expect challenges around inconsistent policies and changing regulations.  Companies that are reliant on improving infrastructure in their strategic expansion plans will also need to consider alternative strategies for growth as major projects face long delays.

For more information on Ukraine’s looming crisis, FSG clients can refer to FSG’s latest podcast on the situation in the country.

FSG’s CEO Richard Leggett on MNCs in Emerging Markets—Harvard Business Review

This past Thanksgiving, FSG’s CEO, Richard Leggett posted an article on Harvard Business Review’s website. Weaving in anecdotes from his extensive client experiences and FSG data studies, the article discusses how multinational companies (MNCs) are dealing with the recent economic slowdown in the BRIC countries. While companies face lower growth in traditional emerging market strongholds, they still expect emerging markets to contribute to both high profits and high growth in sum.

The increased focus on emerging markets as a source of corporate profits is a dramatic shift from when FSG first opened its doors in the early 2000s. Corporate expectations at headquarters were low and regional executives were primarily charged with expanding market share. Today, MNCs have adopted a dual strategy of “going deep” in markets while simultaneously and aggressively pursuing the next frontier markets.

The article goes on to raise examples from across the globe. In Asia, as growth is slowing in China and India, MNCs are increasingly looking to ASEAN countries. Indonesia has attracted MNC attention as it has a young and urban growing middle class that will sustain growth. In Indonesia however, there are other considerations for MNCs to address such as high transportation costs compared to the region and corruption. In Africa, the Nigerian economy is perhaps the most exciting frontier market in the world. Due to a complete overhaul in how GDP is calculated, Nigeria will become the largest market in Africa in 2014. An example of the impressive growth Nigeria’s strong fundamentals are supporting is the automobile market which has seen in some cases a 33% increase in sales.

Please follow this link for the original article that discusses each case in detail.

China’s Shadow Banks Impact Your Global Business

China is the world’s second-largest economy yet many executives ignore it as a source of systemic risk to their global business. The biggest risk in China surrounds its banks, yet we hear little about the problem. Executives in China are often say that the government will simply bail out the system if there were a problem, but that discounts domestic political constraints as well as economic ones. For example, if the Fed, which can print the world’s reserve currency, could barely contain the US banking crisis, what makes us think that China can? Is this time different?

China GPD

A major shock to the Chinese economy would have a ripple-effect across the globe because of China’s massive demand for commodities and deep trade linkages with Western markets. When China sneezes, the world catches a cold.

JPMorgan estimates that loans originated by China’s shadow banks may comprise 69% of GDP.   With small Chinese businesses unable to secure bank loans, the shadow banking system has flourished.  Because of low official deposit rates and restrictions on putting money overseas, savers turn to the shadow banking market to earn higher yields, funding the risky credit cycle, while China’s large banks provide additional leverage via wholesale funding.

China GPD

The real risk is not that shadow banks go bad; in fact the Chinese government is actively trying to curb the industry’s growth. Instead the risk is that bad loans in the shadow system bubble up to the systemically important banks that provided wholesale funding, dramatically slowing China’s growth.  Officially, non-performing loans are only 1% of total bank loans, but credible private estimates put the number closer to 10% The problem became clear this June when the People’s Bank of China (PBOC, China’s Central Bank) engineered a cash-squeeze to pressure the shadow banks, and the banks stopped lending to each other pushing interbank rates to 13.4% overnight (SHIBOR).

China GPD

Before the 2007-2008 crises in Europe and the United States, similar interbank indigestion was a strong leading indicator of the looming credit bust.

While the Chinese government is taking actions to manage this risk, companies should also take action by building scenario plans into their long-range business plans.   Better to build in insurance, even for something perceived as low risk, as economic history has a tendency to repeat itself.

What the US Government Shutdown Means For Emerging Markets

Closed until further noticeThe Fed will delay the tapering of its bond buying program in response to the US government shutdown. For emerging markets this means a slower pace of currency depreciation into year-end, and the potential for limited short-term appreciation in markets that may have over-corrected, like Turkey and Indonesia. With currency depreciation slowing, fourth quarter GDP results may surprise slightly to the upside. The dollar-denominated ETFs that track local Turkish and Indonesian stock markets both increased 4% on the news.